ESG Hedge Funds Are Hot, But Still Have Ways To Go

After a decade of underperformance and outflows, hedge funds are having to deal with another innovation in the world of asset management: ESG (environmental, social, governance). Though the theme has been slow to pick up among hedge funds and other institutional investors, pension funds have started to get into ESG despite concerns that investing with those factors in mind will eat away at returns. As a result, we are starting to see some ESG hedge funds pop up. 

Perhaps the most high-profile ESG hedge fund that was started recently is Inclusive Capital Partners, which was started by ValueAct Capital co-founder Jeffrey Ubben. The fund officially started on July 1, and Ubben told Institutional Investor that the fund is a "return-driven environmental and social activist firm." 

Ubben also told the media outlet that for most people, ESG investing means lower returns because of the inclusion of environmental and social factors. However to him, impact investing means strategy change, which also means "excess return when the market is presuming the status quo." 

Interestingly, Inclusive Capital Partners will own the companies that most ESG funds try to avoid, like oil and gas companies, utilities, chemicals and refineries, and food processing. The fund's mission statement says that such companies have what's needed to "positively impact the transition to a healthier society and planet." 

Why ESG Hedge Funds Are Still Rare

Ubben made a name for himself as an activist investor, so it comes as no surprise that he should find another way to stand out from the many asset managers out there. Funds like Inclusive Capital Partners are still relatively rare, although a few big names like BlackRock are starting to dabble. Some recent studies show us why. 

A recent study conducted by the Alternative Investment Management Association found that only 15% of the hedge fund managers surveyed had adopted ESG strategies. Hedge fund managers blame inconsistent data and a lack of expertise for their avoidance of ESG. 

Approximately 63% of asset managers said a lack of quality, consistent data on sustainability was the biggest challenge in making decisions about ESG investment. The consortium said picking up significant alpha signals from the data that's provided is extremely difficult.

More than one-third of asset managers were confused about terminology, and 25% said ESG wasn't relevant to the investment strategy followed by their fund. This was especially true of funds that invest with a short-term mindset. 

Will Hedge Funds Turn To ESG More Fully?

One of the big concerns about ESG investing is that it may reduce returns, but IPE said some see the matter as a "virtue discount," meaning that funds accept underperformance in the short term in exchange for the longer-term good. 

Others argue that as momentum in ESG investing picks up, more and more money will be following so-called "good" companies, which will cause them to outperform in the long term. Performance data does suggest that ESG will outperform in the long term, even if it underperforms in the short term. 

Of course, for hedge funds, short-term underperformance isn't acceptable. However, funds could start looking to ESG as a possible solution if they can find a way to invest impactfully without sacrificing near-term returns. 

About the Author

Michelle Jones is editor-in-chief for ValueWalk.com and has been with the site since 2012. Previously, she was a television news producer for eight years. She produced the morning news programs for the NBC affiliates in Evansville, Indiana and Huntsville, Alabama and spent a short time at the CBS affiliate in Huntsville. She has experience as a writer and public relations expert for a wide variety of businesses. Email her at Mjones@valuewalk.com.